East Coast Yachts, Inc., has been in merger talks with West Coast Sailboats for the past six months. After several rounds of negotiations, the offer under discussion is a cash offer of $352 million for West Coast Sailboats. Both companies have niche markets in the boating industry, and the companies believe a merger will result in significant synergies due to economies of scale in manufacturing and marketing, as well as significant savings in general and administrative expenses.

Larissa Warren, the president of East Coast Yachts, has been instrumental in the merger negotiations. In conjunction with Dan Ervin, the companys financial analyst, they have prepared the following pro forma financial statements for West Coast Sailboats, assuming the merger takes place. The financial statements (see accompanying Excel Workbook) include all synergistic benefits from the merger.

Dan Ervin is also aware that West Coast Sailboats division will require investments each year for continuing operations, along with sources of financing. The accompanying Excel Workbook includes a worksheet detailing the required investments and sources of financing.

Larissa feels that the capital structure at West Coast Sailboats is not optimal. If the merger takes place, West Coast Sailboats will immediately increase its leverage with a $71 million debt issue, which would be followed by a $96 million dividend payment to East Coast Yachts. This will increase West Coast Sailboats debt-to-equity ratio from 0.50 to 1.00. East Coast Yachts also will be able to use tax-loss carry-forwards of $16 million in 2015 and $16 million in 2016 from West Coast Sailboats previous operations. The total value of West Coast Sailboats is expected to be $576 million in five years, and the company will have $192 million in debt at that time.

Stock in East Coast Yachts currently sells for $94 per share, and the company has 11.6 million shares of stock outstanding. West Coast Sailboats has 5.2 million shares of outstanding stock. Both companies can borrow at an 8% interest rate. The risk-free rate is 6%, and the expected return on the market is 13%. Dan believes the current cost of capital for East Coast Yachts is 11%. The beta for West Coast Sailboats stock given its current capital structure is 1.30.

Larissa has asked Dan to analyze the financial aspects of the potential merger. Specifically, she has asked Dan to answer the following questions.

1. Suppose West Coast Sailboats shareholders will agree to a merger price of $68.75 per share. Should East Coast Yachts proceed with the merger? (Hint: ultimately must find NPV of the acquisition)
2. What is the highest price per share that East Coast Yachts should be willing to pay for West Coast Sailboats?
3. Suppose East Coast yachts is unwilling to pay cash for the merger, but will consider a stock exchange. What exchange ratio would make the merger terms equivalent to the original merger price of $68.75 per share?
4. What is the highest exchange ratio East Coast Yachts would be willing to pay and still undertake the merger?
5. What if East Coast Yachts wanted to acquire West Coast Yachts instead? Assuming the share price and number of shares outstanding are the same as above, as well as the costs of debt and capital, should East Coast acquire West Coast by issuing debt, equity, or a combination of both? What would the new share price be in each of the acquisition combinations?
6. What are some of the problems that could occur after a merger or acquisition transpire?

West Coast Sailboats Investment Needs 2015 2016 2017 2018 2014 Investments Net Working Capital $12,800,000 Fixed Assets 9,600,000 Total $22,400,000 Sources of Financing New Debt $22,400,000 Profit Retention 0 Total $22,400,000 $16,000,000 16,000,000 $32,000,000 $ 16,000,000 11,520,000 $27,520,000 $19,200,000 76,800,000 $96,000,000 $19,200,000 4,480,000 $23,680,000 $10,240,000 21,760,000 $32,000,000 $10,240,000 17,280,000 | $27,520,000 $9,600,000 17,280,000 $26,880,000 $7,680,000 16,000,000 $23,680,000 West Coast Sailboats Pro Forma Financial Statements Sales Production costs Depreciation Other Expenses EBIT Interest Taxable income Taxes (40%) Net Income 2014 $512,000,000 359,200,000 48,000,000 51,200,000 $53,600,000 12,160,000 $41,440,000 16,576,000 $24,864,000 2015 $576,000,000 403,200,000 51,200,000 57,600,000 $64,000,000 14,080,000 $49,920,000 19,968,000 $29,952,000 2016 $640,000,000 448,000,000 52,800,000 64,000,000 $75,200,000 15,360,000 $59,840,000 23,936,000 $35,904,000 2017 $720,000,000 505,600,000 53,120,000 72,320,000 $88,960,000 16,000,000 $72,960,000 29,184,000 $43,776,000 2018 $800,000,000 564,000,000 53,600,000 77,600,000 $104,800,000 17,280,000 $87,520,000 35,008,000 $52,512,000 West Coast Sailboats Investment Needs 2015 2016 2017 2018 2014 Investments Net Working Capital $12,800,000 Fixed Assets 9,600,000 Total $22,400,000 Sources of Financing New Debt $22,400,000 Profit Retention 0 Total $22,400,000 $16,000,000 16,000,000 $32,000,000 $ 16,000,000 11,520,000 $27,520,000 $19,200,000 76,800,000 $96,000,000 $19,200,000 4,480,000 $23,680,000 $10,240,000 21,760,000 $32,000,000 $10,240,000 17,280,000 | $27,520,000 $9,600,000 17,280,000 $26,880,000 $7,680,000 16,000,000 $23,680,000 West Coast Sailboats Pro Forma Financial Statements Sales Production costs Depreciation Other Expenses EBIT Interest Taxable income Taxes (40%) Net Income 2014 $512,000,000 359,200,000 48,000,000 51,200,000 $53,600,000 12,160,000 $41,440,000 16,576,000 $24,864,000 2015 $576,000,000 403,200,000 51,200,000 57,600,000 $64,000,000 14,080,000 $49,920,000 19,968,000 $29,952,000 2016 $640,000,000 448,000,000 52,800,000 64,000,000 $75,200,000 15,360,000 $59,840,000 23,936,000 $35,904,000 2017 $720,000,000 505,600,000 53,120,000 72,320,000 $88,960,000 16,000,000 $72,960,000 29,184,000 $43,776,000 2018 $800,000,000 564,000,000 53,600,000 77,600,000 $104,800,000 17,280,000 $87,520,000 35,008,000 $52,512,000